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Wednesday, July 15, 2009

Don't Let Your Home Loan Haunt You

Source : The Straits Times, July 12 2009

In picking a mortgage package, factors such as interest rates and lock-in period matter.

Nothing beats having your own pad - especially the very first home you own.

For me, it was a 732 sq ft studio in Siglap that I bought in 2005.

When I paid the 1per cent deposit for the place, everything about it was perfect. It had an unblocked view of the East Coast, nice Italian marble flooring, a spacious kitchen (yes, single men do cook) and a huge balcony.

It had all the ingredients of a picture-perfect yuppie life.

I saw myself chilling out on lazy Saturday afternoons on the balcony, whipping up al dente pasta in the kitchen and taking cool evening walks by the beach, which was just around the corner.

So, like most Singaporeans, I emptied my CPF account, signed up for a home loan and, three months later, became the proud owner of my very own bachelor pad.

Buying my first home was a relatively painless and seamless process at the time.

All I did was put my John Hancock down on some papers - actually legal documents which I did not even bother reading - and there I was: a 20-something, first-time homeowner with a $250,000 mortgage.

Everything was cool until I received a letter from my bank just a couple of weeks before my first instalment payment was due.

It was my first mail at my new address and naturally I was ecstatic about opening it, but my fervour died when I read its contents.

The letter said something to the effect that because of fluctuations in the interest rate environment, my monthly instalments would have to be increased. In other words, I needed to pay more each month to service my home loan.

I was shocked. I had not even started unpacking my cartons of belongings and here was the bank telling me my monthly instalments had been raised.

That, however, is the reality that many often face when taking a home loan with variable interest rates, as I would later learn.

Buying a home is arguably one of the biggest financial commitments people will have in their lifetime, and a home loan is the heaviest debt they will have to pay if they take up a mortgage.

It baffles me now that I had actually signed up for a quarter-of-a-million dollar loan without carefully considering the conditions that were tied to it.

As the saying goes, the devil is in the details, and my sin was complacency. But what was an even bigger surprise was that many first-time homeowners were just like me.

I polled my peers and found that most of them also could not recall details like what interest rates their loans were on, how much their monthly instalments were, or even when their loan tenures would end.

Maybe we were just so preoccupied with the excitement of getting that dream home that we ignored the due diligence that should have gone into our hunt for the loan.

For me, the sheer number of banks that offered home loans and the various options available certainly added to the confusion. But I recently found out - when I was buying my second home - that a little research can go a long way in avoiding nasty surprises.

So if interest rates are what really matters to homeowners, then it will probably be a relief for you to know that there are really only two main types of home loan in the market: loans with fixed interest rates, and loans with variable or floating interest rates.

With a fixed rate loan, you are somewhat protected from the fluctuations of interest rates, and typically you can expect to pay the same monthly instalment for at least the first few years of the loan tenure.

So if you want some sense of certainty that your monthly payments will always remain the same, go for a loan with fixed rates. But it is only really any good if you sign up for the loan when interest rates are low.

However, if you do sign up for a fixed rate loan, bear in mind that the annual fixed rate - which these days could go as low as 1.5per cent per year - usually ends after the initial one to three years, depending on your bank. After that, you will be charged the bank's prevailing variable or floating rate, which for many is where the confusion and worries start.

Loans with variable or floating rates are of course the other alternative you could choose right from the start.

The interest rates of these loans are benchmarked against references like the Singapore Interbank Offered Rate or Sibor.

Sibor is the average interest rate at which banks borrow from one another. The key determinant of this is the United States Federal Reserve rate and overall liquidity, or availability of funds, in the banking sector.

Since the economic crisis broke, the Fed has so far managed to keep interest rates at 0.25per cent, a historical low. At the same time, Sibor has hovered at just around 0.7per cent in the last half year.

There is also another type of variable loan, one where interest rates are pegged to the Swap Offer Rate or SOR.

SOR essentially comprises Sibor plus the lending costs incurred by the banks, and is calculated over a period of time: usually three or six months.

For example, if your loan is based on a three-month SOR, your interest rate will be the three-month SOR plus a small margin for the bank, and that rate will be revised every three months.

Like Sibor, SOR is available to the public in newspapers and on the Internet. But SOR is also affected by the exchange rates of the US dollar versus the Singapore dollar, so it tends to be a little more volatile than Sibor.

Of course there are other factors to consider when signing up for a home loan. They include making sure you have the capacity to service the monthly payments, and are comfortable with the interest rates and lock-in period that come with the loan package.

Lock-in periods determine how long you are tied to the bank and allow it to penalise you if you decide to redeem your loan early.

So do not just get excited over what are now staple freebies such as legal fee subsidies, property insurance or even the free shopping vouchers that come with some home loan packages.

Getting the right home loan can mean more peace of mind and maybe even some savings in the long term.

Shop around for a loan that fits your needs instead and keep an eye on the details that really matter when signing up for one - whether it is a fixed or floating rate loan.

You really do not want to match your dream home with a nightmare of a home loan.